Founder, CEO of Blue Lake Capital LLC. Helps passive investors grow wealth through real estate. Podcast Host: REady2Scale.
The multifamily space has been performing incredibly well for the past two-plus years with record demands for rentals, surging rental rates and accelerated demographic changes that have had people flocking to new markets in droves. In aggregate, this helped drive historically high occupancy rates and double-digit rent growth, resulting in historically high returns for owners and investors in the space.
Now, as the calendar runs out on 2022, multifamily real estate is facing pressures across a variety of fronts including sharply rising interest rates lingering supply chain issues, geopolitical issues, record-breaking inflation, declining consumer confidence, pressures on rent and the looming threat of a recession.
The common take from economists is that we’re likely heading toward a recession (paywall) in 2023, the depth and severity of which are the cause of some debate. While optimists are hoping the Fed can hit its goal for a soft landing, a more traditional recession would mean that a full recovery could take place over years, and impact all asset classes.
It sounds ominous, and we’re already seeing some of the impacts in the multifamily space. But what will 2023 hold for multifamily owners, operators and investors?
A Return To Normalcy
Despite the headwinds, the multifamily market remains on solid footing. We’re most likely just starting to see a return to normal. While vacancies in many markets have jumped, they still remain low from a historical perspective. Similarly, while we are seeing a slowing in rent growth, it’s likely that we will continue to see higher levels than what was typical prior to the pandemic in the near and mid-term.
Part of what’s buoying the multifamily market are the ongoing issues facing single-family housing. Real estate brokerage Redfin is predicting that housing sales will sink to their lowest levels since 2011, but an overall shortage of inventory and lack of new builds will keep prices from crashing, even in the face of high rates. In 2021, the National Association of Realtors estimated that there was a shortfall of over 5.5 million units; it’s unlikely the gap has closed much since then.
The economy will have a lot to say about this, of course, especially if a recession is deeper than anticipated and the job market is more severely impacted than we’d like.
Opportunities Still Exist
In terms of opportunities, from the perspective of an owner/operator of large multifamily properties, this could be a great time to invest if you have capital to close and can find properties in the right markets that fit your business model, assuming you can be nimble.
I believe there will be investment opportunities in this market; some sellers may not have a choice. They may have a loan that is due or be overleveraged and need to free up capital.
While sellers will have to come to terms with increasing price pressures, so too will investors have to adjust expectations on their end, but I see those with the capital to get through the present interest-rate environment being well-positioned to weather the storm long-term.
When capitalization rates go up, real estate prices decrease. Investors then adjust the projections in terms of the yields that they’re expecting. The takeaway should be that, although returns are not what they were before, they’ll still be good. My strategy is to currently focus on strong cash flow and seek fixed-rate loans that allow rates to float in the mid- to long-term when interest rates go down again.
Meanwhile, multifamily construction has been on the upswing, meaning a flood of new units will be coming online in 2023. That growth trend will likely continue, given multifamily units generally make more financial sense for builders compared to single-family units.
I believe the newer units could create new opportunities in the space for experienced operators who can bring a value-add approach to slightly older assets, profitably improving the property while bringing rents up to market levels and creating affordable yet updated units for renters.
Multifamily Is Still A Great Investment Class
Multifamily housing has typically set itself apart from other asset classes through all economic cycles, but it’s also been seen as a relative safe haven during recessionary cycles. As we look ahead to 2023, even with the headwinds in the market now, there’s no reason to think this will dramatically change.
This market will bring the most benefit to those who have experience with effective underwriting and have flexibility to change their business models to maximize the opportunity. I find that multifamily remains a good asset class if you buy right, don’t buy at an artificially low cap rate and finance with reasonable leverage.
Just as bad deals can occur in good times, these are the times when those who can create and execute good deals will come out ahead.